Andrew Kerr's  Instablog

The share price of Starbucks Corporation took a particularly large hit during 2007 and 2008 as investors believed that the company had over-extended itself in a premium coffee market that appeared to be under threat. CEO Howard Schultz was put back at the helm of the company in January 2008 and within less than six months had announced the closure of 600 of its US stores in attempt to decrease the cannibalization of its own sales.

The company's most recent earnings, for its fiscal third quarter ended June 28th, reported that net earnings for the 13-week period were USD 151.5M compared to a net loss of USD 6.7M in fiscal Q3 2008. Starbucks also saw higher operating margins at 8.5% compared to negative 0.8% over the year-earlier period. However, the company's comparable store sales revenue declined 5%. The company has also taken a more cautious approach to its international expansion as international results were hurt by lower numbers of transactions and declines in the value of each transaction.

Starbucks released its VIA Ready Brew nationwide across the US at the end of September. The product is an answer to investor fears that premium coffee would be one of the first things that recession-hit consumers would drop from their shopping lists. The company hopes that the product will boost its bottom line, offering cash-strapped consumers a cheaper option to get their premium coffee fix at less than a dollar per cup.

We should focus on the company's long-term fundamentals when making any long-term investment decision. After splitting the company's key long-term fundamental indicators into three groups (Business, Management, Price-Attractiveness) we run them though our proprietary StockMarks rating models, placing the company on a scale of 1-100. The chart below shows Starbucks Corporation's ratings for the three fundamental groups as well as a combined 'Total StockMark' rating since mid-2005.



SADIF last recommended Starbucks as an investment on October 13th 2008. The stock has since risen 87%, compared to the 31% increase in the broader Nasdaq composite index. Despite a P/E ratio of 62, the highest of the company's ratings is its Price StockMark, which is based on SADIF's proprietary valuation algorithms, taking into account both fundamental and technical indicators to arrive at a rating of the attractiveness of a company's stock to long-term investors at its current price. However, this rating is declining as the stock price continues to rise. The business rating remains above the US market average as cost savings and higher margins offset lower revenues. The management rating, which is based on fundamental measures of management efficiency, has increased since Howard Schultz became CEO in early 2008.

A recent poll from ChangeWave Research revealed that consumers are intending to purchase more coffee from Starbucks over the current quarter, while expecting to reduce expenditure on coffee from McDonalds (MCD). While we believe that McDonalds remains a solid investment, Starbucks has greater potential based on its underlying fundamentals and market strategies. The company has proved the resilience of its business over the past 12 months, while maintaining a strong position to take advantage of any global economic recovery.

A summary of our current StockMarks ratings for Starbucks Corporation is available here

Disclosure: No positions

UK-based ICAP plc is the world's largest interdealer broker. During 2008 the company saw a significant shift in its trading mix as banks shifted towards higher liquidity financial instruments such as treasuries, while shying away from less liquid investments such as structured products. This trend climaxed in September 2008, when single-side trade volume in US Treasuries peaked at an average daily volume of USD 172.8B, contributing to a total average daily volume of USD 903.2B on the company's electronic broking platforms, a figure since unmatched.

ICAP's most recent trading update, for September 2009, revealed that total daily trade volume on the company's electronic platforms averaged USD 633.7B, with 115.9B attributable to US Treasuries. ICAP benefited from the volatile markets, reporting record profits for the year ended March 2009. However, the company has since indicated that it expects lower profits for the half ended September as the result of higher investment costs and lower trading in its lucrative electronic trading business lines. Nevertheless, the company expects half-year revenues to rise 6% due to solid overall volumes.

In order to assess the company objectively we split its long-term fundamentals into three groups, business, management and price-attractiveness. The fundamentals are then run though our proprietary StockMarks rating models, placing the company on a scale of 1-100. The chart below shows ICAP's ratings for the three fundamental groups as well as a combined 'Total StockMark' rating since late 2006.



The price rating, which takes into account both fundamental and technical indicators, has shown the greatest increase as the company's stock became undervalued during the third quarter of 2008. ICAP's management rating, which measures efficiency on a fundamental level, remains above the UK market average. Similarly, the company's business growth rating remains solid above the average.

Compared to one of its key UK-based interdealer broker competitors, Tullet Prebon plc, we found that ICAP has a higher long-term business growth rate. While Tullet Prebon shares have risen an amazing 212% year-to-date, compared to ICAP's 63%, a comparison over a longer time period, since the start of 2007, shows ICAP has outperformed Tullet Prebon by 32%.

We currently believe Tullet Prebon to be an above-average long-term investment.

A summary of our current ratings for ICAP plc is available here

Disclosure: No positions

Shares in US-based online retailer Amazon.com have recovered much of the ground lost during the bear market due to continued revenue growth and increasing free cash flow. The company revealed in its second quarter results announcement that net sales were up 14%. Much of the hype surrounding Amazon's business relates to its Kindle e-book reader, which features a paper-like dynamic display. Despite the success of the Kindle over the past two years, the product's competitors such as the Sony Reader are yet to gain significant footing. Amazon is resolved to defending its market share, announcing on October 7th that they intend to drop the price of the Kindle from USD 299 to USD 259, while at the same time introducing the product overseas, in over 100 markets. The new US & International Wireless version of the Kindle is expected to be released on October 19th. The company's second quarter results announcement also revealed that Amazon has continued to expand its business lines, moving into the sale of cell phones and wireless plans for AT&T and Verizon Wireless. In the second quarter Amazon launched its MP3 music service in France, which will likely benefit from new anti-piracy laws enacted on September 22nd. The last SADIF report on Amazon gave the company a positive outlook in July of 2008. The stock has since risen almost 40%. However, in order to assess whether this trend will continue, we should look at how the company's long-term underlying fundamentals have changed over the past 15 months. After splitting the company's key long-term fundamental indicators into three groups (Business, Management, Price-Attractiveness) we run them though our proprietary StockMarks rating models, placing the company on a scale of 1-100. The chart below shows Amazon's ratings for the three fundamental groups as well as a combined 'Total StockMark' rating since early 2006.

Despite a decline since the start of the year, the price-attractiveness rating (Price StockMark) is the strongest of the company's three sub-ratings and suggests that the company's stock price still has significant room to increase based on Amazon's underlying fundamentals. The company's long-term growth rate has improved relative to the US market average over the same period. Amazon's low SMM is common among high-tech growth companies due to above average expenditure on R&D and higher reinvestment levels.

Amazon shares has far outperformed both the Nasdaq composite index and traditional book retailers over the past year. Barnes & Noble (BKS) for example, shows far weaker growth, with a business rating of 36. Shares in Amazon have risen 56% over the past year, compared to a 14% decline in Barnes & Noble shares.

Overall, we continue to believe that Amazon is an above-average investment, based on the company's long term fundamentals and sound strategic position in the online retailer industry.

A summary of our current StockMarks ratings for Amazon.com is available here

Disclosure: No positions

US-based Altria Group is a holding company with subsidiaries operating in tobacco products and alcohol. Altria is also the largest shareholder in UK-listed brewer, SABMiller plc, with a 27.37% stake. The non-cyclical nature of the company's products prevented Altria shares from dropping as far as the broader market during the past year. However, the company's stock has lagged behind the market during the strong recovery over the past six months. Altria Group's business lines are under constant threat of regulation. Altria owns Philip Morris USA, the largest tobacco maker in the US. In June, President Obama enacted a law giving the Food and Drug Administration authority over the tobacco industry. Altria supported the move, while rivals such as  Reynolds American Inc fought the regulation and have challenged the law, stating that it violates their right to free speech. One of the moves that the FDA has made since the law came into effect was the September 22nd ban on all sales of flavored cigarettes excluding menthol. Altria's Philip Morris USA was unaffected by the ban, while another one of its subsidiaries, John Middleton, makes flavored cigars, which continue to be legal and may benefit from the ban. During the second quarter of 2009, Altria saw a 8.9% increase in diluted earnings per share due to stronger profits in its cigarette businesses, the acquisition of UST LLC, and higher earnings from its SABMiller equity investment. Nevertheless, when assessing the company as a long-term investment, we should take into account its long-term fundamentals. After splitting the company's key long-term fundamental indicators into three groups (Business, Management, Price-Attractiveness) we run them though our proprietary StockMarks rating models, placing the company on a scale of 1-100. The chart below shows Altria Group's ratings for the three fundamental groups as well as a combined 'Total StockMark' rating since mid-2005.

The business rating is the weakest of Altria's three sub-ratings as the company's long-term growth rates fall below the US market average. Although the price rating rated above average duing the period between mid 2006 and the end of 2008, the continued weak investor sentiment towards the stock has caused the SMP to decrease steadily since the start of the year.

Altria rates higher than its US competitors, including Reynolds American Inc (RAI), Vector Group Ltd (VGR) and Lorillard Inc (LO). The company also out-rates its major UK-based competitors, Imperial Tobacco PLC (ITYBY) and British American Tobacco (BTI). However, we maintain our negative outlook on the tobacco industry as regulations limiting the companies' operations continue to strengthen.
Overall, we currently believe Altria to be a below-average long term investment.

A summary of our current StockMarks ratings for Altria Group is available here

Disclosure: No positions

From an investor's perspective, peer grouping definitions have become increasingly intricate due to the ever-growing complexity of listed companies, which range from local and single product firms to global multi-sector conglomerates. The definition of 'peers', will depend on an individual investor's investment strategy and goals. There are no shortage of different investment strategies in use today. With the increase in the availability and complexity of backtesting tools, investors can create and test a strategy with a few clicks. However, there are some widely accepted strategies, both for individual investors and mutual funds, such as value investing, growth investing, or investing based on industry/sectors. The distinction can be drawn between investing based on fundamental indicators such as P/E multiples or economic value added (as in value, growth etc), and the more subjective determination of a company's main business line (industry/sector based strategies).

Why then do we continue to rely on a company's industry as the main determinant of its peers? Some investors may choose to invest based almost entirely on industry performance. This can clearly be seen when, for example, a bank (Bank A) reports strong earnings – shares in the bank's rival (Bank B) will tend to increase based on very little information other than the fact that one of its 'peers' is performing well. Has any additional value really been created by Bank B to warrant the increase in its share price?   Investors are taking a calculated risk, believing that barring any unexpected catastrophe, Bank B's performance will move in-line with its industry.

Industry-based peer lists have the difficulty of grouping all of a company's operations into a single item. Take for example General Electric, a company generally categorized on industry lists as an 'Industrial Conglomerate'. However, the industry title does not convey the company's large media and financial interests.

On the other hand, competitive peer analysis does have its place. Given the commoditized nature of paper products for example, weak results at Paper Company A is a reasonable indicator of weak results at Paper Company B (after taking into account extraordinary items). Paper companies are also more likely to fit solely into the 'Forest & Wood Products' industry category, as they tend to lack multiple major business lines.

Selecting peers purely on the basis of price multiples or other fundamental factors can equally lead to some very disappointing results as they lack the 'common sense' factor that is present in industry analysis. A biotechnology company with the exact same financials as a paper company would likely be trading at a higher price, due to speculation and the reasonable judgment that the biotechnology company has better growth opportunities.

It is clear from an investor perspective that neither categorizing peers purely on the basis of fundamentals or competition is ideal. When we select peers for our StockMarks stock rating system, we take into account 16 different attributes which are grouped into four main categories: market league, business similarity in terms of income streams, technology/non-financial assets and financial structure. Our focus is on the long-term fundamental performance of the company, as this aligns with our investment objectives of sustainable long-term returns. No single definition of 'peers' will suit every investor. Technical analysts for example may choose to completely ignore the industry factor and the company's fundamentals, instead grouping companies by the correlation of their share prices. Nevertheless, it is always wise for investors to be wary of the use of any peer list if it was not created with their particular investment strategies and goals in mind.

Disclosure: No Positions

Canadian oil and gas company Canadian Natural Resources has seen high volatility in its share price over the past year as a result of uncertainty in energy prices. Canadian Natural's most recent quarterly results for the second quarter of 2009, reveal that the company's production of both oil and gas have declined over the past year. Canadian Natural's gas production dropped 12% compared to the second quarter of 2008, due to natural declines in base production and the company's strategic decision to direct spending towards higher-return crude oil projects. Canadian Natural ramped up production at its new oil sands mining operations – producing an average of 59,599 bbl/d, up from 3,384 bbl/d in the first quarter of the year. The phase 1 plant has a capacity of 110,000 bbl/d. The company's results announcement indicates that the benchmark price of oil fell further than 50% between the second quarter of 2008 and the same period in 2009. NYMEX oil prices have dropped almost 40% since September of 2008. Despite the volatility in oil prices, Canadian Natural prides itself on its stability and liquidity. 94% of the company's production is located in G8 countries and Canadian Natural has a proactive hedging program to limit the negative effects of volatility in oil prices. However, when we are assessing the company as a potential long-term investment, we should focus on its long-term underlying fundamentals. After splitting the company's key long-term fundamental indicators into three groups (Business, Management, Price-Attractiveness) we run them though our proprietary StockMarks rating models, placing the company on a scale of 1-100. The chart below shows Canadian Natural's ratings for the three fundamental groups as well as a combined 'Total StockMark' rating since December 2006.



The long-term business growth rating has remained stable since the first quarter of 2008. The company's management efficiency rating, based on long-term measurements of factors such as return on assets and earnings per employee, has deteriorated.

Canadian Natural's price-attractiveness rating (Price StockMark) dipped in mid 2008 as the company's share price significantly disconnected from its underlying fundamentals due to the spike in oil prices. However, since oil prices have come down and investors moved away from the stock, we now believe that the CNQ is trading at a price below its fundamental long-term value. The rise in the price-attractiveness rating over the past year more than offsets the decline in the management rating. The company's SMP and overall SMT suggest that Canadian Natural is an above-average long-term investment.

A summary of our current StockMarks ratings for Canadian Natural Resources is available here

Disclosure: No positions